The world of luxury watches, traditionally admired for its craftsmanship and aesthetic appeal, has increasingly captivated the attention of investors seeking alternative asset classes. Beyond their tangible allure and the diversification benefits they offer against traditional financial markets, recent in-depth research has begun to uncover a fascinating dimension: the presence of unique behavioural pricing anomalies that present compelling opportunities for contrarian investors to generate alpha. Unlike more conventional assets, the luxury watch market, particularly its robust secondary segment, exhibits certain market inefficiencies driven by investor sentiment, attention, and market structure, creating fertile ground for strategies that run counter to typical investment wisdom.
The market for luxury watches has experienced a remarkable surge, fuelled by globalisation, increased global wealth, particularly among middle and high-income groups in developing economies, and the rise of online niche marketplaces that facilitate data collection and transactions. The pre-owned luxury watch market alone was estimated at $27 billion in 2022, nearly half the size of the primary market, with forecasts suggesting it will surpass the primary market by 2033. This growing interest is partly due to the desire for portfolio diversification amid uncertainty and volatility in traditional asset markets.
However, the luxury watch market also possesses distinct characteristics that differentiate it from other asset classes. Exclusivity is a key element, often maintained by high prices and consciously limited sales volumes. Many popular models, such as specific Rolex GMT-Master II watches, have waiting lists stretching up to 20 years, leading to a "dried out" primary market and a booming secondary or "grey" market. This secondary market, whilst offering improved liquidity and price discovery for collectors, is largely unregulated, unlike traditional assets. Transparency is often low, and detailed historical data can be limited or require payment, making expertise in specific watch brands and models "valuable, and expensive". The prominence of online platforms like Chrono24 and WatchCharts, which aggregate data from various retailers and forums, has significantly increased market awareness and enabled systematic analysis. This unique market structure, coupled with factors like illiquidity and the prevalence of ask-prices rather than transaction prices, creates conditions where behavioural anomalies can thrive.
One of the most striking findings in the luxury watch market is a significant negative momentum effect. This directly contradicts the positive momentum typically observed in equities and many other asset classes, where past winners tend to continue outperforming, and past losers continue to underperform. In the luxury watch market, the opposite holds true: watches with the lowest recent returns – the "past losers" – tend to generate highly significant and economically large positive returns in subsequent periods.
Research indicates that investing in the lowest momentum quintile portfolio can significantly outperform the highest quintile portfolio, and even the overall luxury watch market portfolio, by an average of 0.75% per month. For example, the lowest momentum quintile portfolio (losers) has been shown to generate cumulative excess returns of 2.10% over one year, with only a slight reversion in the subsequent year. This phenomenon is observed across various past return periods, from two-month to sixteen-month returns. While initial negative returns of past winners mean revert towards zero, the cumulative excess returns of past losers remain above their initial response in subsequent periods. This persistent rebound of underperforming assets forms a powerful basis for a contrarian investment strategy.
Another important behavioural anomaly is the MAX effect, which refers to maximum price fluctuations. In the luxury watch market, a zero-investment strategy that longs (buys) high-MAX watches and shorts (sells) low-MAX watches generates a highly significant negative return of -0.65% per month. This effect is robust to different definitions of MAX, even when using only recent price information. For instance, average returns significantly drop from the fourth to the fifth quintile of MAX.
This finding suggests that investors can generate alpha by actively avoiding watches that exhibit "lottery-like characteristics" or extreme price fluctuations. Such speculative, high-volatility assets tend to be detrimental to overall portfolio performance. A prudent contrarian approach, therefore, involves steering clear of watches with excessive MAX characteristics, potentially favouring those with more stable, lower MAX profiles.
The behavioural anomalies observed in the luxury watch market are strongly linked to mispricing, often influenced by investor sentiment. The underlying theory posits that during periods of high sentiment, optimistic projections can inflate asset prices, leading to overvaluation that is difficult to correct due to inherent short-selling restrictions. Conversely, in low-sentiment periods, assets may be more realistically valued or even underpriced.
Research indicates that periods of high sentiment are likely to be followed by lower returns on overpriced luxury watches, and vice versa. This demonstrates an "arbitrage asymmetry," where overpriced assets are more susceptible to sentiment-driven effects than underpriced ones. The "hold-more effect" is also relevant: increased investor demand, even if driven by sentiment, can amplify overall market risk, leading to higher expected returns in equilibrium. However, the initial price surge may not be driven by fundamental signals, suggesting common mispricing.
Real-world events underscore this connection. The discontinuation of the popular Patek Philippe Nautilus 5711 in January 2021 saw its average market price surge by 45% within two months. This was further amplified when an additional limited edition, seen on celebrity Jay-Z, led to a further significant price increase for the non-limited Nautilus. However, there is strong evidence that prices sharply decreased after the sample period in March 2022, with average prices for Rolex watches on secondary markets declining by 15% between January 2022 and January 2023, and the Subdial50 Index losing 33% within a year until February 2023. This post-peak decline, following a period of remarkable price increases fuelled by sentiment, supports the notion of a mispricing correction. The initial price increase was "conceivably not related to fundamental signals resulting in common mispricing, complementing the previously detected arbitrage asymmetry".
Further analysis of the inverse momentum effect reveals that it is often more pronounced among low-attention watches. This implies that overlooked "loser" watches present better alpha opportunities than widely scrutinised ones. This finding challenges the conventional view in equity markets, where momentum is often linked to high attention.
When using Google searches as a proxy for investor attention, studies have found that the momentum effect in luxury watches is not driven by investor attention. Instead, it is the past losers in the low-attention group that generate significant excess returns. This suggests that contrarian investors should seek out less visible watches that have recently underperformed, as these are the most promising candidates for substantial rebounds. The "size (AGE)" characteristic (number of months listed on Chrono24.com) also forms a successful long-short strategy, generating a "highly significant positive premium of 0.48% per month until Feb. 2020", which is notably not related to investor attention.
Another unique aspect of the luxury watch market, especially relevant for optimising investment performance, is its seven-day trading nature, unlike traditional stock markets which operate on five business days. Research into this continuous trading environment has identified peculiar day-of-the-week effects: luxury watch returns are generally lower on Sundays.
This phenomenon contradicts theories of investor attention and mood, which would typically predict higher returns on weekends due to increased individual investor activity and potentially more optimistic sentiment. Instead, the explanation lies in the market's specific mechanics. Most luxury watch sellers on major online marketplaces like eBay are professional dealers, with over 80% of Rolex offers, for example, providing a warranty typically granted by commercial sellers. Given that Sunday is typically a day of rest in most Western countries, professional dealers rarely update existing listings on that day. This leads to a virtual absence of price discovery on Sundays, resulting in lower (ask-price based) returns. Therefore, understanding these trading patterns allows investors to time their transactions for potentially better entry or exit points.
The convergence of these distinct behavioural anomalies presents a potent alpha angle for discerning contrarian investors in the luxury watch market. By identifying and capitalising on these market inefficiencies, investors can strategically position themselves:
Targeting "Loser" Watches: Systematically investing in luxury watches that have experienced the poorest recent performance, expecting a significant reversal due to the pronounced inverse momentum effect.
Avoiding Lottery-Like Assets: Prudently steering clear of watches exhibiting high maximum price fluctuations (MAX effect), as these tend to generate negative returns.
Leveraging Sentiment: Recognising the impact of investor sentiment on mispricing. This involves understanding arbitrage asymmetry and the "hold-more effect" to anticipate corrections in over or undervalued watches.
Focusing on Low-Attention Opportunities: Prioritising less scrutinised watches that have underperformed, as these often present the most significant alpha opportunities due to the inverse momentum being more pronounced in low-attention assets.
Optimising Transaction Timing: Utilising the observed day-of-the-week effects to potentially buy watches when returns are historically lower, such as on Sundays, taking advantage of the reduced price discovery driven by professional seller behaviour.
It is crucial for investors to conduct thorough analysis and possess a comprehensive understanding of the luxury watch market, including its prevailing trends, key players, and the granular factors influencing prices. While luxury watches offer substantial diversification benefits and can reduce overall portfolio risk due to their low correlation with traditional assets, their illiquidity often necessitates a longer investment horizon to capture these contrarian gains effectively. Moreover, it is important to distinguish between investing in physical watches and investing in the shares of watch manufacturers, as they present different risk and return profiles. By diligently unearthing and acting upon these unique behavioural anomalies, a contrarian investor can truly harness the power of "The Contrarian Clock" in the luxury watch market.
Featured Image: Photo by Chris Lutke on Unsplash